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Two thumbs up? The Bernanke Fed has been bold in its attempts to tackle the crisis - Photo credit: Gerald R. Ford School of Public Policy

Fed Chairman Ben Bernanke’s attempts to stimulate the economy through monetary policy may be failing, as the latest producer price index (PPI) presented a deflationary scenario. PPI has now fallen for a third consecutive month, the Bureau of Labor Statistics announced on Tuesday, indicating deflationary pressures have built up in the economy. On Wednesday, the BLS is set to release the consumer price index (CPI), which fell 0.3% in November and is expected to come in flat for December.

While PPI and CPI aren’t all-encompassing measures of the success of monetary policy, they do provide good insight into the state of the economy, and thus of Bernanke’s record. PPI fell 0.2% in December, after having fallen 0.8% in November and 0.2% in October. In a yearly basis, producer prices rose 1.3% in 2012, dramatically slower than the 4.7% registered in 2011.

Looking at the different components, it was food and energy prices that brought the index down. Food prices dropped 0.9% while energy slid 0.3%, as a slower global economy has weakened demand for commodities; in the case of energy prices, oversupplied markets also played a role.

Core PPI, which excludes the highly volatile food and energy indexes, rose a tepid 0.1%, below expectations, according to Barclays, which noted that the decline in the overall index was also more pronounced than forecast; they expect fourth quarter GDP to grow 1.3%.

Deflation, along with high unemployment, is a central bank’s worst enemy. In the specific case of the Federal Reserve, its dual mandate requires it to focus on price stability and maximum employment. While a few months of negative PPI and CPI numbers aren’t decisive evidence that a deflationary cycle is upon us, they should raise some red flags, even though the Chairman insists that inflation expectations are firmly anchored.

Bernanke has been in the hot seat ever since the Fed unleashed its repeated programs of quantitative easing (QE), or longer-term asset purchases. Critics suggest the Fed is incurring too deeply into uncharted waters, and that the potential benefits have yet to be seen; they fear Bernanke's massive balance sheet expansion has set the U.S. up for a bout of inflation that will be difficult to control. Tuesday's numbers may suggest something different: that the Fed's capacity to influence economic variables via QE is more limited than previously thought. Indeed, the unemployment rate remains elevated at 7.8% and economic growth, if it does come in at 1.3% for the fourth quarter, is highly troubling.

The labor situation doesn’t seem to be improving materially either. Over the past few months, major banks like Citi and Morgan Stanley announced layoffs, while American Express noted in its latest earnings release that it plans to reduce its headcount; a few days ago, Boeing cut 160 positions at a Texas facility. And while the unemployment rate has fallen, it has done so at a painfully slow rate, and is expected by the Fed to remain fall to between 6.7% to 7.6% only by 2014, well above the 5.2% to 6% range they consider normal.

In defense of Bernanke, the Fed is an institution that can help with an economic recovery, but it doesn’t have the tools to spark growth from one day to the next. The Chairman has repeatedly said that monetary policy is no “panacea,” urging Washington lawmakers to do their part and help, through political stability and fiscal sustainability that doesn’t impose too much austerity.

In a speech on Monday, the Chairman once again spoke optimistically of the housing sector, which the Fed has directly stimulated via low interest rates and purchases of residential mortgage backed securities; over the past 12 months, homebuilders like Lennar and KB Home have seen their stocks rally about 80%, compared to a nearly 14% gain for the S&P 500.

After the massive shock caused by the financial crisis, Bernanke’s Fed unleashed QE2 in the face of a deflationary cycle seen early in 2010. Since late 2011, CPI has embarked on a volatile path, bouncing off the flat line only to fall below it twice. Bernanke insists inflation expectations remain firmly anchored, but a continuation of the current path should give the Chairman food for thought, especially as the Fed is currently engaged in an $85 billion-a-month round of QE that should be causing the exact opposite outcome.